Investing for the Long Term Not So Hot for Venture Capital

TechFlash reports: The venture capital industry used to be able to point to historical returns as evidence that—even though bets in the sector were risky—they still paid off in the long run.

And while that's still the case to a degree, the numbers are slipping. And they're slipping fast. A report released today by Cambridge Associates and the National Venture Capital Association indicates that 10-year returns at venture capital firms fell to 14.3 percent for the period ending June 30. That compares to a 10-year return of 26.2 percent for the period ending June 30, 2008.

The reason for such a big drop? The dotcom boom year of 1999—a year which saw 16 companies from Washington state go public (including the likes of Drugstore.com, ImageX, and WatchGuard Technologies)—is starting to fade out of the 10-year results.

And that's having a big impact. The artificial highs created during 1999 no longer will get counted in the 10-year results, which means we're likely to see that time horizon deteriorate even further. That's especially the case as the years of 2001, 2002, and 2003—extremely tough periods for the venture industry—start getting factored in.

It will be interesting to see what impact the deteriorating numbers have on the venture capital business: Smaller funds? Fewer limited partners participating? A true shakeout and consolidation?

And it will be worth watching over the coming quarters if that 10-year horizon slips into the negative, lagging behind other benchmarks such as the S&P 500, Nasdaq Composite, and Dow Jones Industrial Average. (Of course, those benchmarks also will fall for the time period as the tougher economic climate gets factored in).

Mark Heesen, president of the NVCA, offers a cautious note in a statement announcing the results.

"We are now entering a period of time when the stark differences between today's exit market and the exit market 10 years ago will be manifested in the return numbers in a meaningful way," said Mark Heesen, president of the NVCA. "Without a stronger IPO market, and by stronger I am suggesting a multiple of 8 to 10 times the current volume, these longer-term performance numbers will continue to deteriorate over the next few years."

Ouch.

On the bright side, the survey of 1,281 U.S. venture capital firms showed that for all of the major periods (1-year, 3-year, 5-year, 10-year, 15-year, and 20 year) returns outpaced the major stock indexes.

And one-year venture capital returns—which stood at 4.7 percent as of June 30—actually were far, far ahead of the pubic markets. By comparison, the Nasdaq Composite was down 20 percent for that period.

Nonetheless, the survey stresses how important it will be for the IPO and M&A market to open up if the venture capital industry wants to stake its claim as the place to be for high-risk, high-reward investments.